The ability to understand your expenses when analyzing a short term rental investment is critical. Income is only one side of the equation. If you are able to effectively understand your expenses, you will be able to put together projected cash flow numbers. This will help you determine if a property is worth investing in.
Before reading this article, if you haven’t already checked out my Understanding the Inputs post, start here. This post will help you understand some critical inputs you will need for effectively analyzing the income side of the equation for short term rentals.
The Two Main Ways to Get A Short Term Rental Property
When looking to understand what expenses come with short term rentals, there are two main ways people get a property. These are the common purchase of a property or master leasing.
Purchasing a property is pretty straight forward. The main downside of purchasing a property is capital. Purchasing properties will take more cash to get started. There are a significant number of benefits to purchasing. I won’t go into the details in this article, but you can read through some pros and cons of purchasing a home here.
The second common practice used is master leasing a property. What is master leasing? When you master lease a property, you are signing an agreement with the landlord allowing you rights to sub-lease. To learn many more intricate details of how master leasing works, you can go here.
You would be able to sublease the property for the duration of the signed lease. One thing I want to make clear on my viewpoint of master leasing. Master leasing can be a great option for someone with less capital. If this is a strategy you would like like to implement, make sure you provide full transparency to the landlord. Let them know your intention of what you plan to do with the property. I believe it is unethical to not be honest with any landlord you are trying to master lease with. Ensure to tell them your exact intentions with the property.
Okay, now that we got that part out of the way, let’s get into how to understand your expenses for both scenarios. Before jumping in, to clarify, this is how I run my numbers. This is not the only way to run the numbers for a short term rental. This is how I run the numbers when analyzing short term rental investment properties.
Understanding Your Expenses – Common Expenses
Below are the common expenses you will have for your property regardless of buying or master leasing:
Utilities: this will be any utility costs associated to the property. Typically, this will include cable, internet, electric, heat, and water.
Misc. Expenses: This category was put in the analysis so you can add extra expenses for one off scenarios. I don’t want to clutter the template with line items for too much. If you have a miscellaneous expense, put that here. An example of this type of expense is pool maintenance. I currently pay $90/month for a pool guy to service my property.
Understanding Your Expenses – Purchasing a Property
The most common thing for real estate investors to do. Let’s look at a snapshot of the different expenses it is important to understand:
As the owner of a property, you will incur more expense lines than if you were renting. This is natural based on the nature of how you are operating the property.
Let’s first touch on the expenses that will be different from master leasing. These include: Principal & Interest Payment (P&I), HOA/Condo Fees, Capital Expenses, Property Taxes, and Yearly Insurance.
What is P&I? This is your principal and interest payment. When purchasing a property, you will have loan terms and an interest rate. These to things will help determine what your principal and interest payments are each month.
What are HOA/Condo Fees? When you are an owner of a property, you must make sure you account for HOA/Condo Fees. These aren’t common in all parts of the country, but you need to factor this in. High HOA or Condo Fees can very quickly turn what you thought was a good investment to a bad one. For example, my property in Orlando has an HOA fee of $351 per month. I am more than happy to pay this for a few reasons. The HOA takes care of the exterior of the entire home including lawn maintenance. This fee also includes free access to my guests to all amenities within the resort. I made sure to factor this cost into my analysis before purchasing.
What are Capital Expenses? Capital expenses are the larger expenses like a new roof, remodeling kitchens, painting the exterior, replacing an AC. These are some of the most common capital expenses but not the only ones. Each month, you want to put away a percentage of your income to the side. This will be used when you have one of these larger expenses pop up. For example, earlier this month, I received a text from my pool guy letting me know the pool pump needed to replacement. This would is a capital expense and ended up costing me $2,400. That is part of the business, so don’t forget to account for this in running your numbers! I currently use 10% for this when running my numbers. Why? I have generally heard that is how much you should put away for capital expenses. So that is what I do. No crazy analysis for that one.
What are property taxes? Uncle Sam will always want his fair share. Part of owning a property is paying property taxes. If you are looking at properties on the MLS, you should be able to see the most recent tax year bill. One thing to be careful about. Property taxes typically increase over time. This will change every year based off new assessments made by the government.
What is yearly insurance? This is just your normal yearly insurance on a property. To get a good estimate, call some insurance providers in your area and talk through property characteristics. This will help you ballpark this number. For all your numbers, it is always good to be a little conservative. This will only help you in the long run. As you get a few properties, you will be able to dial in these numbers to become more accurate.
Understanding Your Expenses – Renting or Master Leasing A Property
When renting or master leasing a property, the below expenses will need to be defined:
- Rent: This is pretty straightforward, but this will be the monthly rent payment for the home.
- Operational Expenses: If you would like to add extra operational expenses per month, I have added a line to do so.
Key Takeaways:
- There are two main ways to get a short term rental property. You can buy a property or master lease.
- Doing either of these strategies will change how to properly analyze the property. Understand what is necessary to use for either purchasing or master leasing
- Whenever you plug in numbers, do as much research as possible to closely approximate costs. When in doubt, always overestimate expenses so your numbers are conservative.
Don’t forget @TheYoungRetireeBy33’s 3 Core Principles:
1 – Your money should make money for you⠀⠀⠀⠀⠀⠀⠀⠀⠀
2 – Start early to realize the power of compound interest⠀⠀⠀⠀⠀⠀⠀⠀⠀
3 – Eliminate your largest expense by house hacking
